GFC? What GFC?

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‘Financial crisis a distant memory’ reads a headline in today’s The Australian.

Uh-oh.

That seems to be the consensus opinion. The ‘GFC’ – as it is flippantly referred to in Australia – visited our shores briefly, and then departed…never to return.

When you’re walking around in the underbrush, the canopy of trees tends to block the light. Only a few slivers make it through. It can be dark and dangerous down there.

But that’s where bankers and analysts are hanging out.

And they’re pretty excited about The Commonwealth Bank’s (CBA) chunky half-yearly result, announced yesterday. Australia’s largest bank made a profit of $3.33 billion in the six months to 31 December.

The result represented a 13 per cent improvement (on a cash basis) on last year. Now that sounds pretty good on the surface but it was driven entirely by further falls in bad debt charges, or impairment expense.

This time last year CBA incurred bad debt charges of $1.383bn against yesterday’s $722m. That’s a $661m improvement.

Moving back up the profit-and-loss statement though, we find that CBA’s operating performance was flat year-on-year. This potentially gives us a sneak preview of what the cash profit growth figure will look like (i.e. flat) at the full year result in August because the big boost to profits from falling bad debt charges is over.

This slow growth future was of little concern to investors yesterday. The share price soared. It appeared as though many were expecting a poor result. Either that, or all those nasty foreigners who are betting on a property market collapse in Australia were forced to cover their short positions.

CBA has 53 per cent of total assets tied up in home loans (total assets includes foreign assets, so as a percentage of Australian assets it would be much higher) making it a target for short sellers looking to profit from falling property prices.

But Aussie property prices will never go down, because: we have China; commodities; a highly urbanised population, coastal living – which is extremely desirable (and therefore more expensive); and oh, yes, an undersupply of housing given our high population growth, which means newly arrived migrants will need to borrow half a million for a shack on the edge of a city…

So the short sellers might be off to lick their wounds for a while, but they’ll be back. The other major ingredient in Australia’s house price miracle is (or rather has been) credit growth.

It has slowed down in a big way.

If banks are vampires, then credit growth is the blood that sustains them. The only way for banks to increase their assets (and therefore profits) is to increase lending. Your debt – whether business, home or personal – is a bank’s asset.

According to a recent release from the RBA, credit growth (it sounds better than debt growth) was just 3.4 per cent in the year to 31December. That’s far from the halcyon days of around 15 per cent growth just before the credit bubble burst.

If the financial crisis is a distant memory, why aren’t we seeing resurgent credit growth?

It’s because the household sector is maxed out. People are saving and paying down debt. The household saving rate is around 10 per cent.

CBA boss Ralph Norris might not appreciate this new frugality (his assets have only grown 4 per cent over the past year) but on the other side of the ledger the inflow of savings (in the form of deposits) takes some pressure off funding costs.

Domestic deposits now fund around 60 per cent of CBA’s assets, meaning the bank has to borrow less from wholesale funding markets, which is a more expensive source of funding.

Keep this in mind next time you hear someone squawking about ‘cash on the sidelines’ just waiting to flow into equities. If everyone takes their cash and buys equities, the banks lose a massive source of funding (assuming those who sell the equities don’t put the proceeds back in the bank!)

Like it or loathe it though, the banks’ profitability is impressive. Return on equity increased to 19.2 per cent, up from 18.9 per cent, for the 2010 financial year.

So good in fact that Ralph Norris doesn’t really want to talk about it. Instead, he wanted to talk return on assets, which was only around 1 per cent.

Of course this ignores the fact that banks are highly leveraged institutions. If return on assets is 1 per cent and return on equity is 19.2 per cent, then you have…leverage, and lots of it.

This is why banks are inherently fragile and cause everyone grief when they take too much risk. It’s also why they should come under greater regulatory scrutiny. Not because they make ‘obscene profits’ – that’s what they’re meant to do.

Henry Kaufman (who was a big hitter on Wall Street for three decades before starting his own research firm in 1988) says it best when arguing for stricter bank regulation:

‘…because financial institutions are entrusted with an extraordinary public responsibility. They have a fiduciary role as the holders of the public’s temporary funds and savings. They generally have large liabilities (other people’s money) and a small capital base and are involved in allocating the proceeds from these liabilities to numerous activities that are critical to the functioning of our economy.’

The only problem is, the regulators haven’t a clue what they are doing or what they are trying to achieve.

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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32 Comments on "GFC? What GFC?"

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Stillgotshoeson
Guest

@Ross, Lachlan, Watcher

From theage.com.au

“Australian shares rose slightly today, taking the All Ordinaries over 5000 for the first time in 10 months”

Do you think it can hold and even rise much further or do you expect strong resistance at this level?

IMP doing quite well at the moment Ross.
Focus look to be making good progress this 1/2 year Lachlan

Lachlan
Guest
Been out a few days Shoes and have not analysed markets yet, except to see some pick up in my goldies while I was away. When I left early week I was neutral to bearish (short to int. term only) because there was some unfinished business out there….the Dow has been behaving perfectly like it would just prior to a sharp shakeout like the flash crash I expected around now. There are potential weaknesses in the All Ords I am not well versed in…financials etc. Let us know what you think about that. I’m sticking with PMs and commods for… Read more »
Lachlan
Guest
“Do you think it can hold and even rise much further or do you expect strong resistance at this level?” I’ve had a better look Shoes. I still expect a shake-out but it’s not a good bet to call it now, better to be neutral because we could see a pop-higher in the Ords and the AUD even. And the Dow is extended but that does not mean it won’t get worse. When risk gets into reverse the AUD chart would look nice with a visit down to about 89cents or so. But yeah I’m not hung up over resistance… Read more »
Stillgotshoeson
Guest
I am expecting a shake out too, property and shares, PM’s as well, probably them first then shares then property later on. I think one of my earlier posts on this site, (may have been Barefoot Investor Column) was that I would not be surprised to see the DOW got to 14 or 15 thousand before the next correction, however the next correction is still going to come. We would need to see QE III for 14 or 15 thou, I am not sure the “market” would buy QE III. 5250 to 5500 is my best guestimate for the ASX,… Read more »
Lachlan
Guest
” I fail to see any fundamentals for it to really break that level.” I don’t see a solid case for natural credit growth and improving business conditions either shoes. However my case for gold miners at least is based on fundamentals…the fundamentals of human nature, the nature of money, the history of central banking and proof of Bernankes ability to monetise debt and shove it down the markets throat via bank buddies at JP et al. Also gold price vs share price movements of last few years for value plus technical case for AUD gold going forward. Then the… Read more »
Ross
Guest
@Shoes, might be best to stick with Watcher. Having said that now I have no opinion other than the sneaking suspicion that it may not end predictably, even in gridiron terms. I have been selling down for a while now but in doing so missing gains despite the combined black ink from on an 08-09 portfolio. If I don’t have a strategy I realise the gains and limit the losses. I’m selling some soft commodities but keeping my fingernails in NAM (don’t expect a great next earnings report) and VTA and GNC. If I wasn’t so deep in TSE myself… Read more »
nv
Guest

“and oh, yes, an undersupply of housing given our high population growth, which means newly arrived migrants will need to borrow half a million for a shack on the edge of a city…”

The ‘government’ could of course permit more building but that would be too easy and goes against the grain of the banksters’ balance sheets.

No permission = monopoly = price control

nv
Guest

“But Aussie property prices will never go down, because: we have China; commodities; a highly urbanised population, coastal living – which is extremely desirable (and therefore more expensive); and oh, yes, an undersupply of housing”…..because our ‘government’ will not permit more building because that would be too easy and goes against the grain of the banksters’ balance sheets.

No building permission = monopoly = price control

The ‘government’ throttles affordable housing at the behest of the banksters.

Nice scam if you can get_in on it.

Lachlan
Guest

A mate of mine inherited a house in Brissy somewhere. He had it valued at 310K last year. Had it revalued a month ago at 240K. His wife is pretty dark because she nearly sold it last year.

Biker
Guest

Hmmm… Very tough call, Lachlan:

* Sell it quickly, before it falls further?*

* Rent it?

* Hold it?

Gotta feel sorry for them, don’t ya?!~ ;)

* Get the address, quick, Ned! HaHa… .

Lachlan
Guest

I would not sell for fear of further fall at this stage since that’s already a steep fall.
Yes I’d be tempted to feel dark if I were them because they missed some easy profits.
My options would be either rent or sell for another investment….but that’s going to be getting a tough call with the price beaten down already.
I’m guessing its an older house judging on price range but we didn’t discuss it.

Ned S
Guest

Be interesting to know if it is in a flood affected suburb Lachlan. If so it could very well fall further? If not, it’s a very sizable drop alright. Must admit my impression certainly wasn’t that bottom end stuff generally had taken hits anywhere near as big as that.

Lachlan
Guest

It’s only a valuation to be fair Ned although I’m hoping to catch up with this fellow next couple weeks so I shall find out more. He’s an old gold panning mate from on top the ranges. Hoping to knock off a few pans for old times after the big flood. Knowing me I wont get there for six months and he’ll give up on me ;)

Ned S
Guest

There have been some complaints coming out from RE types about valuers valuing as if drops that ‘could’ happen have already happened Lachlan. Though at that sort of a drop in that price range the first thing that still comes to my mind has to be “flood affected”. Looking forward to hearing the details.

Never turned my hand to any gold fossicking – One of these days as they say. Good luck with it!

Lachlan
Guest

” I hope my book gets published and sells”
I remember some time back Ross you said you were going to write a very long piece on here, maybe a piece regarding your political/economic viewpoints. Maybe that’s what it was going to be, I cant’remember. I know you submitted the piece because I saw it briefly however I never had time to read it at the time and lost track of it’s whereabouts while I was away. I should have saved it. Know where its been left…anyone??

Lachlan
Guest

“Good luck with it!”….maybe there will be more talking about digging then actual digging Ned …and remembering another old mate who died a few years ago from cancer of everything. He loved this old spot out in the scrub. It is a beautiful, quiet place, always some clear water and birdlife, frogs, deer etc. While there we’ll say gidday to his ghost who might be sampling the gravels with a pan or sipping port in the dark of night beneath the stars…in fact we should have buried him out there but there are laws you know :)

Biker Pete
Guest

Ned: “The first thing that still comes to my mind
has to be “flood affected”.

Can’t blame *sigh* Clone Steve, then, Ned? ;)

Stillgotshoeson
Guest
Comment by Lachlan on 11 February 2011: A mate of mine inherited a house in Brissy somewhere. He had it valued at 310K last year. Had it revalued a month ago at 240K. His wife is pretty dark because she nearly sold it last year. I’m not them, and I am not a financial advisor.. legit or otherwise.. So me personally.. First question you can not answer, However it would be the obvious one to ask.. What would they have done/will do with the money if the sold? My negativity towards property as an investment is the leverage factor to… Read more »
Stillgotshoeson
Guest
Comment by Ross on 11 February 2011: @Shoes, might be best to stick with Watcher. Having said that now I have no opinion other than the sneaking suspicion that it may not end predictably, even in gridiron terms. I have been selling down for a while now but in doing so missing gains despite the combined black ink from on an 08-09 portfolio. If I don’t have a strategy I realise the gains and limit the losses. I’m selling some soft commodities but keeping my fingernails in NAM (don’t expect a great next earnings report) and VTA and GNC. If… Read more »
Stillgotshoeson
Guest
Comment by Lachlan on 11 February 2011: Also gold price vs share price movements of last few years for value plus technical case for AUD gold going forward. Then the leverage of shares over the underlying commodity price gains…as you have said also. Gold in AUD is post “negative” news for Australia Depending on the dollars drop, I see othe complications from it too.. Price of Petrol being high on the list.. Melbourne and Sydney are large cities, many suburbs mean a daily commute of many kilometres for many workers.. Petrol at $1.65 or higher is going to dent an… Read more »
Stillgotshoeson
Guest

Comment by Lachlan on 10 February 2011:

Longer term I’m sticking with Bernanke to print and pump with markets generally up or sideways but NOT capitulating to a lower than March 09 low. There will be divergences in the performances of sectors over time in response to the actions of the US Fed.

I am expecting capitulation. My belief is new lows will be tested… Still optimistic for the future… My heavyweight to PM’s verify my current “bear” status

Davo
Guest
Lachlan, I agree with shoes. I’d be renting the property out. Because of the floods, there are a LOT of displaced families here in Brisbane that need somewhere to live, which will most likely force up rental yields, as supply/demand equation comes into play. Uninsured properties won’t get repaired unless the owners have the capital backing to repair them, so supply may be tight for some time in those affected areas. I’d be confident in saying the house isn’t in the Brisbane City Council area, as you can’t buy anything for those sort of bucks. Most likely in an outer… Read more »
Davo
Guest
Every 3 months or so, I go on to onthehouse.com.au and check out sold properties in my suburb here in Brisbane, to see if the market really is crashing like many people seem to think. They get their numbers from official Government sources, so I don’t dispute them. I live in a suburb that’s quite large and has a real mixture of properties from flats, units, “average” family homes up to the seriously wealthy. It costs $5 from memory to sign up and they have information on several states, so I’d recommend those interested in what’s happening in their own… Read more »
Ned S
Guest

“people no longer thinking it’s so wonderful to live on a river, looking to either move (if they can sell) or others relocating from elsewhere who want to be near the CBD and don’t want to run the risk of being flooded”

Similar thoughts about the effect of the flooding Davo – Flood areas could tend to become no go zones for home owners with little expectation of capital gain and prices dropping off to simply reflect rental return. With that potentially making competing non flood affected suburbs like yours more valuable than they would otherwise have been.

Biker Pete
Guest

Actually reduces a.) the number of homes in an urban area; b.)the number of viable homesites. Have to agree prices of properties unaffected will rise.

Lachlan
Guest

I checked up on that house and the facts were a little different but just a little. Original valuation was 305K and recent valuation 249.5K which is around 18% mark down as opposed to 22%. Its been 2 months since I was told Valuations both prior to any flood so flooding not cause of mark down. I don’t know Brisbane well but the area was Acacia Ridge.
Within same family is another residence which has been revalued from 675K to 605K in Melbournes western suburbs.
It’s not often we get to see prices going backwards. These are valuations only, not sales.

Lachlan
Guest

Shoes I took a hit on income during the flood and just getting back on board but otherwise would be buying small-caps on this latest dip.
Davo, Shoes I feel uncomfortable telling friends what I think they should do with money in this global casino but with some downside risk removed on home values renting the house would seem reasonable to me also. You can always invest the income with more time to think/analyse. I enjoy investing my own income for that reason. Each time cash comes through I already have a reasonably well developed idea what to do with it.

Stillgotshoeson
Guest
Comment by Lachlan on 11 February 2011: Within same family is another residence which has been revalued from 675K to 605K in Melbournes western suburbs. It’s not often we get to see prices going backwards. These are valuations only, not sales. Melbourne: I expect Western and Northern suburbs to be hard hit in any correction, large base of FHB’s, Immigrants and Semi and Unskilled workers. Could rattle of a Dozen or more Suburbs that are of concern. Not too willing to tell people what they should do, happy to say what I am doing and why.. Comment by Lachlan on… Read more »
Lachlan
Guest

PIO went well Shoes after it got away on us and has pulled back to a lower risk entry level I like . Otherwise I’d have bought it and ALY also last week. To think I’m owed money too..grrr…patience man , patience ;)

Stillgotshoeson
Guest
Comment by Lachlan on 12 February 2011: PIO went well Shoes after it got away on us and has pulled back to a lower risk entry level I like . Otherwise I’d have bought it and ALY also last week. To think I’m owed money too..grrr…patience man , patience PIO are still on my watch list, further pull back on the Gold price could see them enter buy territory.. AYN is a silver play on my list as well.. Speculative for sure and it would be a buy and sell on a silver bull run.. I have 35 stocks I… Read more »
John
Guest

A great article, being someone who is heavily invested in banks (Sold CBA due to increase in price). Your article provides a clearer picture to the true valuation on banks by comparing return on assets as opposed to return on equity. Of course the return on equity will be high because they employ leverage and I understand credit growth is static, but the real question I feel is forward looking earnings well into the next few years. That’s the 64 thousand dollar question.

Stillgotshoeson
Guest
Comment by John on 6 March 2011: but the real question I feel is forward looking earnings well into the next few years. That’s the 64 thousand dollar question. I am out of banks, I think the forward looking earnings are not to good. I feel they are going to struggle to get any growth in the next couple of years.. Any “growth” for on or two will come at the decline of the others There are no Bakwest deals for CBA nor St George deals for Westpac (expect a round of redundancies to be announced by Westpac in the… Read more »
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